On 1 and 2 October, Cape Town played host to "PRI in Person" – "the responsible investment event of the year". The United Nations-supported Principles for Responsible Investment (PRI) Initiative is a global network of investors who aim to incorporate sustainability issues, in particular environmental, social and governance (ESG) factors, into investment decisions and ownership practices. By supporting economic development that meets the needs of the present generation without compromising the needs of future generations, responsible investors aim to contribute to the development of a more sustainable international financial system. Historically, South Africa has played an important role in the development of sustainable and responsible investment (SRI) for the wrong reasons. In the 1980s, various institutional investors or asset owners in the USA and UK required funds to be ‘screened’ for investments in apartheid South Africa so that they could be excluded from investment portfolios. Stakeholder pressure ultimately led to divestment and the withdrawal of numerous companies from South Africa in the mid-80s.More recently however, South Africa has made great strides in advancing the cause of sustainable and responsible investment. South Africa was the first emerging market country to have an SRI Index, which was launched by the JSE in 2004, and is widely regarded as an emerging market leader in SRI practices. There are now 44 South African signatories to the PRI Initiative (four asset owners, 32 investment managers and 8 professional service providers, including Kigoda Consulting). Of the emerging market countries, only Brazil has more. South Africa has also advanced the cause of SRI through regulatory changes such as the amendments to regulations of the Pensions Funds Act, which require that funds give “appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character.” Disclosure of relevant ESG information has been encouraged through the King Code of Governance Principles and the listing requirements of the JSE. Most recently, the Code for Responsible Investing in South Africa (CRISA) was launched. Like the PRI Initiative, CRISA encourages the incorporation of sustainability factors into investment decisions and active engagement with companies when concerns have been identified. Considering these various regulatory drivers, it is unsurprising that the sustainable investment market in South Africa is growing. The Global Sustainable Investment Review 2012 estimates that around USD218bn of assets under management in South Africa fall under a broad definition of SRI that covers the self-reported integration of ESG factors. This compares to around USD125bn (about 20% of assets under management) in 2011.

Corporate misbehaviour

However, despite this long list of achievements, there are numerous incidents that highlight that there is still a long way to go before these various initiatives, frameworks and institutional changes start to have a real impact on the way in which investors and companies behave in South Africa. In just the past 12 months we have seen:

the first confiscation order under the Prevention of Organised Crime Act being issued against a company, York Timber, for contraventions of the National Environmental Management Act.

So how do we overcome this contradiction? How do we ensure that the various SRI frameworks support real responsible investment by encouraging companies to meaningfully address the impact that they have on the environment, society and the wider economy? We propose the following:Mandatory reporting - CRISA is a voluntary code that operates on an ‘apply or explain’ basis. It only came into effect in February 2012, but initial indications suggest that adoption of the code is weak. CRISA requires “institutional investors to fully and publicly disclose to stakeholders at least once a year to what extent the Code has been applied”. However, as yet, relatively few disclosures have been made. As a result, it is difficult to assess what progress has been made in terms of implementing the CRISA principles, including the integration of ESG factors. It is reasonably easy for investment managers to sign up to one or other voluntary initiative and declare that it integrates ESG factors into investment decisions. But real ESG integration that prices in negative externalities and addresses the short-termism of many investment decisions needs more than lip-service.

Only by making disclosure mandatory will it be possible for other stakeholders to play an active role, especially as the ‘check and balance’ that CRISA suggests should be in place to ensure that it is successful. The PRI Initiative is moving towards mandatory disclosure; CRISA should follow suite. Be transparent about engagement and voting – in investment jargon, engagement is the process where investment managers work with company management to address shortcomings. At company AGMs, shareholders or their representatives are entitled to vote on various issues such as board appointments, remuneration and special resolutions. Asset managers will often say that they engage behind closed doors, but unless this is transparent, how do we know that they are acting in the best interests of the ultimate beneficiaries, the pension fund members? Similarly, unless votes are disclosed, preferably shortly after the AGM, how is it possible to get feedback on what action has been taken? Recent media reports highlighting how the PIC has used its votes against the remuneration packages of executives at various mining firms show just how important a role active ownership can be in addressing key ESG concerns.More detailed company disclosure – the JSE deserves praise for being the first stock exchange to introduce a SRI index. However, Kigoda Consulting recently found cases where JSE-listed companies are not in compliance with their listing requirements. This should be addressed. Furthermore, unless the JSE introduces more stringent listing requirements it will be left behind international best practice. For example, the JSE currently only requires companies to disclose whether or not resolutions at AGM’s were passed by the requisite majority. By not requiring companies to provide more detail, such as the number of shares voted either way or abstentions, it is difficult for investors to identify where concerns might lie. Raise the bar for inclusion in the JSE SRI Index – South Africa has recently commemorated the anniversary of the tragic events at Marikana. It took many by surprise to find out that Lonmin, the company that employed the striking workers, was a constituent of the JSE SRI Index. Civil society groups have regularly raised concerns over the constituents of the SRI Index highlighting that many, including some ‘Best Performers’, have contravened environmental legislation or been complicit in some other questionable activity. Companies often use inclusion in the Index as a public relations tool, but their performance on environmental or social issues does not necessarily measure up. Unless the bar is raised, the Index will be undermined. Alternatively, the JSE should disclose the assessment used in determining the various constituents so that interested parties can examine where advances have been made and where potential issues might lie.

You raise some extremely valid points all of which I agree with. We have numerous challenges with ESG. The general malaise amongst the investor community I suggest is perhaps the most worrying.

They do not read the reports, or at least do not analyse the disclosures and hold companies to account for what they are doing. There is little understanding of environmental and social impacts of companies and how to assess the value creation potential of an organisation over the short, medium and long term.

This is the crux of the issue.

You touch on the inadequacy of the JSE SRI Index. The barrier to entry is very low, virtually any company can make it onto the index if they follow King III and make some environmental and social disclosures. And this is the problem that the JSE has. How high do you set the bar? How do you separate high impact industries and low impact industries effectively? How do companies account for their indirect impacts, arguably the financial sector has a huge influence on future direction, if they are investing in new coal production - why? Why not renewables? Why not social development projects?

The questions are endless.

The solution, well, it could lie with the IIRC and their integrated reporting framework. Providers of financial capital and companies need to get to grips with it sooner rather than later. The current IRs in South Africa are (mostly) not integrated, with no business model discussion, no linkage between resources and relationships and their impacts on them. This requires full analysis of their material impacts and transparency thereof. IR should allow investors to understand if a business model is set up for long term or short term value creation.

Therein perhaps lies the clue. A resilient business model that creates value for the short, medium and long term should (theoretically) belong in a company that understands its ESG issues and impacts and is willing to embrace change as time progresses. Whether this pans out or not remains to be seen.